Technology can be hit or miss sometimes. Some things catch on while others fall to the wayside. One fact holds true though; the more narrow your focus, the easier it is to see opportunities as they arise. Take Cisco (NASDAQ:CSCO) for instance. It is one of the top Software-as-a-Service [SAAS] companies in the world right now. The company, which specializes in networking and security solutions, had made quite the name for itself a few years back, earning a reputation as one of Silicon Valley's most prolific buyers. At one point, the company was actively trying to gain a standing in 30 different businesses, but it wound up being spread too thin.
Recently, Cisco has been narrowing its focus to just a few core businesses, and it has renewed efforts to acquire companies that fit into this vision. The company announced in mid-March that it would acquire video software company, NDS Group, for $4 billion. NDS's software is used by cable and satellite television providers to run set-top boxes (i.e. the box you connect to your television to access cable or streaming content boxes like Roku) and video recorders (like DVRs). Its software is also used to stream video content and otherwise deliver it to different devices. Cisco reportedly has as much as $5 billion set aside for acquisitions over the next year.
Cisco has sold set-top boxes since acquiring Scientific Atlanta in 2005, but its profitability has lagged compared to other segments. The downward trend will likely only get worse as time goes on, and more companies are offering Internet-ready televisions and other viewing devices that could eventually render cable set-top boxes obsolete. So, why would Cisco acquire yet another company in this industry? Quite simply, NDS has the software that could give it an advantage should cable boxes become dinosaurs of the past, presenting a way for Cisco to hedge its bet on video content.
That said, the set-top box is certainly still strong with consumers. In addition to the popular Roku, Apple (NASDAQ:AAPL) has its Apple TV and Google (NASDAQ:GOOG) offers its own Android-based Google TV. Even Intel (NASDAQ:INTC) has been trying to make inroads into video, specifically trying to get its chips into existing set-top boxes and possibly creating its own video streaming service. True to its SaaS heritage, Cisco's idea with its acquisition of NDS is to target cable providers and content producers, pitching its software as the best way to get their shows or movies on viewers' screens regardless of who makes the actual equipment - a good way to hedge consumer preferences.
I like Cisco. I think that its supply-to-the-suppliers type philosophy is spot on. It works in today's volatile markets - who knows which provider consumers will end up preferring or how long a market leader lasts? - but it also fits with the company's original focus, and there is a lot to be said for staying true to your roots. It is comparatively easier than trying on new hats, because you already know how to serve that role. For example, if Cisco got into the streaming video business, maybe developing its own Roku-type device, it would to compete directly against Roku, Apple TV, Google TV and Internet-ready televisions. By focusing instead (or at least primarily) on providing the software that powers those devices, it increases its potential market share while decreasing its competition in that arena. I think it is a smart strategy, and expect Cisco to go far as a result. I also like the company's metrics.
Cisco is a strong performer. Its net income grew 43.5% compared to the same quarter last year, significantly outperforming both the S&P 500 and its industry's average. The company's revenue did not fare as well, increasing by almost 11%, while its industry moved up over 18%, but the gain is still encouraging, and it still managed to boost its earnings per share. Cisco also has a strong return on equity and attractive valuation levels. The company pays a 32 cents dividend (1.60% yield), which it recently increased, and is priced at $19.91 a share, which is just 10.11 times its forward earnings. The figure is especially low, considering its peers have a price over projected earnings of almost 33.
A discount that big usually indicates a market inefficiency or a stock with poor prospects. Given that analysts predict that Cisco's earnings will increase by an average of just 8.69% a year over the next five years, compared to expectations for its industry of 14.70% and the market of 10.65%, either conclusion is a possibility. Personally, I think the truth is closer to a combination of both. The company's intrinsic value is less than $16 a share, but it also has its most recent acquisition to consider.
I think we are going to see Cisco emerge as a major player, but it will take a few years for that to happen. It has my vote as a longer term position (i.e. over 3 years).
Rival Intel is a strong competitor. Its revenues grew by over 21% compared to the same quarter last year. In turn, the company was able to boost its earnings per share. Intel also boasts very little debt and a quick ratio of 1.54, indicating that short-term cash obligations are no problem for this company. It was able to realize a modest increase in its return on equity, moving from 23.19% at the end of the fourth quarter 2010 to 28.19% at the end of the fourth quarter 2011, significantly higher than its industry's average of 21.56% and the market's average 14.77%.
Intel, which recently traded at $28 a share and pays an 84 cents dividend (3.10% yield), is priced low at 10.63 times its forward earnings. The company has enjoyed a strong gain in share price during the last year, moving up over 27%. I am sure that Intel will continue to go higher - after all, it seems to be "inside" everything now - but I expect the stock to level off in a couple years if it doesn't expand its offerings. Video may be a way to that - but until something more happens in that arena, I am recommending Intel as a shorter-term play.
I also like Intel competitor Qualcom (QCOM). It has strong revenue growth of almost 40%, an improving earnings per share, very low debt and a really high quick ratio of 2.52. The stock has risen pretty well; its share price increased by almost 11% in 2011. Qualcom recently traded for $65 a share and pays an 86 cent dividend (1.30% yield). It all sounds modest but hopeful. Now, consider the fact that the new iPads use Qualcom chips for their LTE technology, and it is easy to see why the company could swell considerably, especially as LTE gains a footing.
All in all, this is a winning sector as more and more people integrate technology into their lives. My recommendation is to hold Cisco as a long position and Intel as a shorter term position. I'm not sure how far or how fast Qualcom will go, but I am hopeful and recommend the company to investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.